Wall Street; A Money Manager's Soap Opera

By Diana B. Henriques

Published: February 17, 1991

One of the hottest new trends on Wall Street has been a staple of romantic fiction since Shakespeare was a pup. You know the plot: The girl has been betrothed for years to the mild but reliable boy-next-door, but she is drawn to the dashing but unpredictable drifter. In the Wall Street version, the heroine is played by your corporate pension fund.

The exciting stranger's part goes to one of those active money managers of Wall Street lore, people who look for individual companies that will dramatically outperform the market. And cast as the boy-next-door is that set of modern-day professionals known, unfortunately enough, as "passive managers." These money managers, also called indexers, don't try to beat the market; they just try to match it, by buying huge but exceedingly dull collections of representative stocks that will behave like the market itself behaves. No worse but (yawn) no better.

Given human nature, it is not surprising that our heroine is tempted. What is unusual is that Wall Street is starting to encourage this little fling -- by devising some innovative products that promise some of the kicks of active management, with fewer of its risks.

There is no argument that active managers, as individuals, are a fascinating lot. You see them on "Wall Street Week," talking about their favorite undiscovered stock. Their tribe includes colorful characters like Mario Gabelli, legendary figures like Warren Buffett, mental monuments like Peter Lynch.

But as a group, these stock-picking professionals have a reputation for being both expensive and unpredictable. As their passive rivals will tell you, active money managers as a group failed to outperform the Standard & Poor's 500 in the great bull market of the 80's, which was fundamentally a large-company boom that bypassed small stocks favored by most active managers.

That, of course, explains the appeal of the passive managers during the 80's. By investing with the indexers, big conservative institutions were assured of matching the index. Their profits were predictable but dull.

Too dull, said Bernard Beal, the chairman of M.R. Beal & Company in New York. "You can't ask people to give up their dreams," Mr. Beal added. People want the potential that the broader market offers -- if they can get it without excessive risk and at a reasonable cost. Thus, his company's new product line: a set of four funds, each of which promises to match the median performance of one of the major styles of active investment management.

In Wall Street parlance, "style" has nothing to do with hemlines or lapels. It refers to how an active manager picks stocks, what criteria drive the decisions.

While there are variations and subsets, most active managers can be classified as "growth managers" or "value managers." The growth style focuses on potential sales and earnings growth; the value style concentrates on how a company's stock price compares to its profits and dividends.

It is the nature of the market that value managers tend to do well when growth managers are slumping, and vice versa. That is why most of the institutional investors who use active managers hire an assortment of them.

Some institutions carry this approach one step further with a contrarian technique called "style tilting," which involves placing heavier bets on the managers who are out of favor, on the theory that they will benefit most from the next market cycle. The concept has been popularized by Performance Analytics, a Chicago firm that tracks the relative performance of different styles and predicts when a shift is in store.

But Robert Moseson, the firm's president and author of its Spectrum advisory letter, concedes that even if you pick the right style at the right time, you run the risk of picking the wrong manager -- the one who, for some reason, fails to keep pace with the typical practitioners of that style.

That problem is supposedly eliminated by the new Beal funds, which have attracted about $20 million in assets since their quiet introduction to institutional investors last September. James E. Francis, the funds' portfolio manager, said each fund is designed to track the median performance of a particular style. Thus, a pension fund sponsor who thinks that value-oriented managers specializing in smaller companies will outpace the S.&P. 500 index this year could elect to invest in the Beal "small-capitalization value fund," which will match the median performance of that investment style. The fees are higher than those of pure indexers -- but considerably lower than those of active managers.

The Beal funds aren't the only new products that offer professional investors a less expensive way to flirt with active management styles. For example, Mr. Moseson advises the "Spectrum Equity Management Account," first offered in December 1989 to trust department clients of the Gary-Wheaton Bank, a subsidiary of First Chicago Corporation. Douglas Eyles, the trust division manager, said the bank uses mutual funds to effect its shifts in style. The account modestly outperformed the S.&P. 500 its first year.

A similar approach, also using Performance Analytics data, is used in the F.M.A. Spectrum Portfolio, a set of largely institutional mutual funds introduced last October by the Regis Fund family, administered by the Vanguard Group. The funds are managed by Fiduciary Management Associates, a Chicago investment firm, and require a minimum investment of $250,000.

What all these innovators confirm is that their institutional clients value the predictability of indexing, but long for the excitement and potential rewards of stock-picking. Which suggests that the simmering rivalry between passive indexers and the much-maligned active managers is far from over.

Chart: "A Matter of Style" Active portfolio managers, defined by the criteria they use to select individual stocks. * "Large Cap" Growth Manager: Looks for rapid and consistent sales and earnings growth among companies with a large market value, or capitalization. * "Small Cap" Growth Manager: Looks for fast-growth companies with a smaller market capitalization. * "Large Cap" Value Manager: Looks for large companies selling at a low price relative to their current earnings and book values. A subset, called "value-income" managers," also look for high dividends. * "Small Cap" Value Manager: Looks for small companies selling at a low price relative to current earnings and book value. (Source: Performance Analytics, Beal Investment, Gary Wheaton Bank.)